Why the Pandemic Could Turn Darden Into an Even Bigger Juggernaut

The casual leader plans to return to growth quickly, and it will have a more profitable system when it gets there.

June 2020 Danny Klein

Restaurateurs and industry experts have continually asked this question throughout the COVID-19 catastrophe: What disruptions will become permanent? Is the “new normal” all-inclusive, or will it pick and choose?

For Darden CEO Gene Lee, the answer isn’t complicated. While the pandemic pressed the casual leader’s entire business—as it did all restaurants—it also opened a “once-in-a-lifetime opportunity,” Lee said. A chance “a lot of us had been waiting for.”

“The most prominent and the most significant thing we've done is streamline the menus and our processes and procedures, and that's forever,” Lee said Thursday during the company’s Q4 earnings, a lengthy recap that reflected on 14 weeks that felt like 14 months.

When Darden shut its dining rooms March 20, an obvious issue surfaced. The company had to simplify offerings to accommodate added off-premises orders.

“Then we had those three weeks or four weeks to really focus at the corporate level with our teams [and say] OK, what do we really need to come back and how do we keep this simple because we had no idea what was going to happen when we open our dining rooms,” Lee said. “We didn't know if anybody as going to show up, right?”

Darden introduced disposable, pared-down menus systemwide, which could be switched out quickly if needed. But what the company also learned was it could squeeze enough variety on the menus to satisfy consumer demand. As many restaurants have noticed in recent weeks, pent-up demand in a COVID-19 rebound is very different than past decision-making habits. Guests seek out favorites, from brands they’ve missed. Variety and discovery aren’t as valued as trust and familiarity.

“That’s been the biggest insight—that some of what I would call the superfluous menu items that are on our menu that one out of 100 people were buying when they were coming in, just aren't important, and most of those created the complexity in the kitchen,” Lee said. “… I think that's what's going to be the lasting change. It's going to have significant impact two years, three years, four years from today.”

THE COVID-19 ROAD FOR DARDEN SO FAR

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Darden spent $75 million on employees during crisis

It wasn’t just menus, either. Darden rethought processes and procedures at a company already known for its “back-to-basics” operating philosophy. Lee said they eliminated a lot of prep work that will never go back in.

There’s already proof it’s working. Despite blended same-store sales dropping 47.7 percent in Q4, Darden turned in slightly positive restaurant-level margin at 0.9 percent. The company credited this to permanent menu simplification and operations improvements that yielded a 150-basis point improvement in hourly expense, offset by managerial costs, hourly emergency pay (a COVID-19 one-time deal), and higher food and packaging costs. BTIG analyst Peter Salah wrote in a note Friday that much of the hourly labor benefit Darden is enjoying will stick as sales recover.

“The improved labor efficiency and less emergency pay suggests restaurant margins are likely respectable [low-to-mid teens] in 1QF20 … far exceeding industry standards that have generally equated a 30 percent sales decline to breakeven profitability," Saleh said. "Additionally, we believe this gives Darden the ability to reinvest in value to draw guests back should capacity constraints ease.”

Woven throughout a historically difficult quarter, Lee provided an optimistic lens for the future—a time when Darden can leverage its new foundation for greater market share. The company said it’s planning to add 35–40 net new restaurants in fiscal 2021, which would represent about 2 percent unit growth. Roughly half of these were construction delays from 2019 when coronavirus tightened Darden’s non-essential budget. Yet while the underlying growth rate is actually closer to 1 percent (given that holdover), management said Thursday the company should quickly return to 2–3 percent expansion in 2022.

Casual dining entered the pandemic as a $108 billion category. Lee expects the sector to get back there. “I think people really miss it, probably miss it more than they know,” he says.

But to what literal, store-count capacity is the real question. Lee didn't want to speculate or throw a number out there. However, he admitted, beyond just casual dining, it’s undeniable the restaurant landscape will emerge with fewer units and less competition on the other side. “I think that’s a great opportunity for us,” Lee said. “I think scale is going to matter more than ever. … We’re going to continue to open restaurants. We’re going to continue to do new deals. We think the economics going forward here in the short term should get better for us on new restaurant development.”

He expects opportunity on the growth front to actually be more favorable than it was pre-COVID-19.

Simply, there will be a lot fewer restaurants expanding. In turn, the cost of construction should come down, just like it did in 2019–2011 out of the Great Recession. The cost of underlying land should fall, too.

“The best restaurant deals we did were after the recession in [2009] and [2010], especially for our specialty brands,” Lee said.

“'I’m really excited about the opportunity to build restaurants,” he added later in the call. “I'm confident in our model. I believe the cost—initial investment cost—is going to be less or at least not be inflating at the rate it was inflating. So we're going to be able to create significant value for Darden going forward, new restaurant growth, and we'll probably be one of the few out there that's opening new restaurants.”

The restaurants Darden actually brings to market, though, are going to carry a coronavirus-era imprint. The big work that needs to be done, Lee said, is understanding what must change inside the box to better support the biggest off-premises trend to come out of COVID-19 for the company—curbside. Until recently, Darden was remodeling to develop capacity for inside pickup. “Now, we’ve got to really relook at that as we go forward,” Lee said. Olive Garden, for instance, was designing dedicated pickup spaces off the side of the kitchen.

Does that really make sense now moving forward, given contactless options and customers desire to stay in the car? “We don’t know,” Lee said. There are simply a lot of learnings left before understanding what the restaurant of the future looks like for Darden. The only sure thing: The company will be building them.

Inside, expect to see more flexibility in dining rooms and floor plans that offer the potential for barriers. Options in case something like this ever happens again.

Olive Garden

Olive Garden is putting up temporary plastic barriers to get more out of its limited capacity seating.

Which brings us to the present

Darden reported a net loss of $480 million in Q4, or $3.86 per share, swinging from net income of $208 million, or $1.67 per share, in the year-ago quarter. It’s adjusted loss per share was $1.24. The company reported revenue of $1.27 billion, down 43 percent from $2.23 billion in Q4 2019.

For the first three weeks of Q1, same-store sales are down 31.3 percent at Olive Garden, which led to Darden’s initial guidance of negative 30 percent for the period.

Olive Garden’s recovery is moving a bit slower than some investors expected, but Darden said there’s a straightforward explanation. It’s a logistical issue, not a demand one. The company’s flagship pushed digital sales 300 percent higher than year-ago levels and is reporting positive comps in 10–15 percent of its units. However, necessitated social distancing within restaurants has limited seating capacity in more challenging ways than Darden’s other brands, namely LongHorn.

Olive Garden typically has twos, fours, and sixes in regards to seating options. It has tables for large parties. Lee said the brand’s average party size is 2.3. Unlike LongHorn, which is essentially one big box, Olive Garden has rooms, nooks and crannies, and shorter booth backs. The chain can’t create the same yield adhering to local jurisdictions as LongHorn, or create the same percentage occupancy.

To address this, Darden is installing temporary barriers in about 100 restaurants over the next two weeks to try to improve efficiency. It will analyze progress and decide how many more restaurants to add. Lee said Olive Garden hopes to get as much as a 20 percent capacity increase from the barriers. “We’re going to put every booth in play,” he said. “Right now, every other booth is out.”

As of June 22, Darden said 91 percent of its 1,700 dining rooms were open with at least limited capacity.

Here’s a look at how sales trended in Q1 (ended May 31) across its portfolio:

Olive Garden: –39.2 percent
LongHorn: –45.3 percent
The Capital Grille: –62.5 percent
Eddie V’s: –65.2 percent
Cheddar’s Scratch Kitchen: –58.5 percent
Yard House: –70.7 percent
Seasons 52: –69.9 percent
Bahama Breeze: –66.1 percent

More recent weekly performance:

Olive Garden

Week ended June 7: –35.6 percent
Week ended June 14: –30.9 percent
Week ended June 21 (includes Father’s Day): –27.6 percent
Quarter to date: –31.3 percent

LongHorn

Week ended June 7: –29.9 percent
Week ended June 14: –22 percent
Week ended June 21 (includes Father’s Day): –21.7 percent
Quarter to date: –24.3 percent

Fine dining (Capital Grille, Eddie V’s)

Week ended June 7: –56.2 percent
Week ended June 14: –48.2 percent
Week ended June 21 (includes Father’s Day): –42.3 percent
Quarter to date: –48.1 percent

Other brands

Week ended June 7: –50.2 percent
Week ended June 14: –38.6 percent
Week ended June 21 (includes Father’s Day): –38.6 percent
Quarter to date: –42.3 percent

And here’s a look at sales for Olive Garden and LongHorn restaurants open with at least limited dining room capacity for the entire week:

Olive Garden

Week ended June 7

Total sales per restaurant: $72,739
To-go sales as percentage of total: 41 percent
Same-store sales: –26.2 percent
Number of restaurants: 598

Week ended June 14

Total sales per restaurant: $75,512
To-go sales as percentage of total: 38 percent
Same-store sales: –24 percent
Number of restaurants: 680

Week ended June 21

Total sales per restaurant: $80,779
To-go sales as percentage of total: 40 percent
Same-store sales: –21.4 percent
Number of restaurants: 729

LongHorn

Week ended June 7

Total sales per restaurant: $54,434
To-go sales as percentage of total: 26 percent
Same-store sales: –17.9 percent
Number of restaurants: 369

Week ended June 14

Total sales per restaurant: $60,460
To-go sales as percentage of total: 24 percent
Same-store sales: –10.8 percent
Number of restaurants: 394

Week ended June 21

Total sales per restaurant: $70,226
To-go sales as percentage of total: 28 percent
Same-store sales: –13.8 percent
Number of restaurants: 426

From where Darden stands today, Olive Garden appears to be retaining roughly 60 percent of its off-premises sales dollars as in-store dining returns, Saleh said in his note.

The brand’s off-premises business peaked around the third week of April, with average weekly sales of slightly less than $53,000, or about 54 percent of historical sales volumes. In the most recent week, with 84 percent of dining rooms open in some capacity, it fell back to $32,200, which is still double the figure from early March.

While early, this could provide a window into the off-premises future for Olive Garden, even when it returns to more normal dining-room business.

LongHorn has navigated a similar path. Off-premises sales boosted its recovery by hitting $28,653, or 41 percent, of pre-virus volumes in the third week of April—nearly four times higher than early March. Today, with 82 percent of the system’s dining rooms running, off-premises is rolling at slightly less than $20,000 per week with same-store sales down 13.8 percent.

Lee said LongHorn’s ability to triple the past number versus Olive Garden’s ability to double it is just a matter of the first starting from a much lower number to begin with.

Olive Garden has tested a few different off-premises strategies during the pandemic. A key change was dropping the threshold of its own fulfilled delivery program from $75 to $40 in most markets. Lee said they’re settling in the $50 minimum now, with average order sizes coming in well above that. Olive Garden also tested its own delivery, which Lee said was “really inefficient and wasn’t that additive.”

“And so, we’re really focused on this curbside operation and think that’s the future for off-premises,” he said. Curbside popped up as a makeshift drive-thru option in parking lots, and Darden is looking at making it even more streamlined through technology, with a focus on payment.

While some third-party delivery testing has been going on, mostly at Yard House, Lee said Darden didn’t see the business grow faster than its own in-house efforts. The opposite was true.

“Now as we've said all the time, that can change as soon as we see or if we see that those margins are equal to what we do today then maybe we'll go into the third-party model. But as of right now our resolve is strong,” he said.

Lee also announced on the call that chief operating officer Dave George plans to retire August 2. George, 65, has been in the Darden system (previous companies as well) for 23 years. In that time, he’s led Olive Garden, Capital Grille, and LongHorn at different stints and held his current role since January 2018.

“He built great teams and became a mentor to many operators and executives. His can-do approach and attitude permeates throughout Darden and each of our brands today,” Lee said.